Best practices, updated every Wednesday

118 posts categorized "Alternative Fee Arrangements"

November 30, 2016

When it comes to offering fee estimates at the start of a matter, far too many lawyers still rely on ballpark estimates that they sometimes pull out of thin air. But even if you follow the “high detail” estimation techniques described in our Legal Project Management Quick Reference Guide (p. 152), the fact that you have a budget does not necessarily mean that you have a price which should be quoted to a client.

Wikipedia lists 25 different pricing strategies suppliers use in other businesses, ranging from loss leaders to premium pricing. The two that are used most often in law are cost-plus and value pricing.

Cost-plus pricing is similar to the traditional hourly billing approach and is exactly what it sounds like: a price is based on the cost of delivering a service plus a markup or profit margin. Normally the markup is already built into the hourly rate, so with this approach you could in fact quote your budget as the price.

Some of the most popular new alternatives for lawyers are built around the idea of value pricing, where the client’s perception of value is the most important factor. The best-known proponent of this approach is Ron Baker, author of several books on the topic. In practice, value pricing is much harder than it sounds. (For details, see chapters six and seven of my book, Legal Project Management, Pricing, and Alternative Fee Arrangements.)

In today’s highly competitive marketplace for legal services, where some firms seem downright desperate for new work, price competition is a giant wild card.

“Suicide pricing” in response to RFPs. These are bids—from name-brand firms, mind you—that are so breathtakingly low one wonders how they could possibly make any money. The short answer is they can’t. These bids come in 5, 10, 20, 40% under what my clients think would be reasonable for the matter. But… firms in an industry with excess capacity face an almost irresistible compulsion to cut prices, even to unprofitable levels. The goal is simply to keep people busy, in service of keeping the firm alive and satisfying clients, and in the hope that once market conditions recover, everything can get back to normal.

The bad news for most law firms is that low prices are the new normal.

When Altman Weil’sLaw Firms in Transition survey asked 356 managing partners and chairs of US law firms about current trends which represented a permanent change in the legal landscape, the top trend was “more price competition.” Ninety-five percent of respondents said this was a permanent change in the legal profession. (Interestingly, number two on their list was a “focus on improved practice efficiency” or LPM, which was rated as a permanent change by 93% of respondents.)

Another challenge is posed by the growing popularity of alternative fee arrangements. When the same survey asked, “Compared to projects billed at an hourly rate, are your firm’s non-hourly projects more profitable or less profitable?” 28% said non-hourly matters were less profitable. Of the remaining respondents, 18% said non-hourly arrangements were more profitable, 42% said they were about the same as hourly, and 13% were “not sure.”

Would you invest in a company that didn’t know which deals were profitable? Of course not. But if you are a partner in a US firm with 50 lawyers or more, there’s a 13% chance you already own one.

A few years ago, an AmLaw 100 firm that was just beginning to think seriously about pricing invited me to speak at a practice group leader meeting about pricing trends. When one participant asked what I thought was the most critical issue, I said it was determining the difference between low prices that are acceptable and prices that are simply too low to make business sense for that firm. “Where do you draw that line in the sand?” I asked. The chairman replied, “We don’t even know where the sand is.”

But that was then. Now that same firm has a pricing director and a number of new pricing and management initiatives in place.

October 19, 2016

Traditionally, lawyers have been trained to place enormous emphasis on avoiding risk, and little or no emphasis on increasing efficiency. As Ron Friedman put it:

Clients often want to know if there are any major risks: “Let me know if there are any boulders in this playing field.” Lawyers often hear that and think they need to find not just the boulders, but also the pebbles. The fear of being wrong—and of malpractice—runs deep. “Perfection thinking” makes it hard to approximate, to apply the 80-20 rule, [or] to guide in the right direction but with some imprecision.

But as in-house departments are increasingly pressured to control costs, they in turn are pressuring outside law firms to find ways to increase efficiency. Business process improvement is one path to the lower costs that many clients are demanding.

While there is widespread agreement that clients also want legal project management (LPM) and that it pays off for firms, the field is so new that experts still disagree about exactly what should be included and excluded from its definition. These arguments have slowed LPM’s progress. For example, consider these remarks from one AmLaw 200 firm leader we interviewed for the book Client Value and Law Firm Profitability (p. 89):

We were just at a board meeting last week where we were talking about whether we should do formalized project management training. My answer to that is obviously yes, we absolutely should. But first we need to agree on what legal project management is.

We first became aware of the seriousness of this problem a few years ago when the director of professional development at an AmLaw 100 firm asked us to explain the differences between project management, process improvement, Six Sigma, and Lean. This was an extremely sophisticated client who had been researching this area for months, but she had heard so many different claims from competing consultants that she had trouble keeping them straight.

Process improvement, has gotten a lot of headlines in the legal world as a result of Seyfarth Shaw’s highly publicized success in using it to streamline work, along with Six Sigma and Lean. All three approaches originated in the world of manufacturing.

Six Sigma is built around techniques Motorola developed to eliminate the causes of manufacturing defects and errors. Lean was developed by Toyota to increase manufacturing efficiency by eliminating the “seven wastes” (excess inventory, excess processing, overproduction, transportation, motion, waiting, and defects).

Process improvement typically starts by defining the exact steps that are required to perform a legal process. This includes looking at every process from the client’s point of view, analyzing whether each step adds value for the client, and eliminating the steps that don’t.

Writing in Law Technology,Alan Cohen has noted that this traditional approach “can take weeks to create a map, but the result is a template that spells out the various phases of a matter—and an efficient way to do them.” If you consider the fact that Seyfarth has developed over 500 process maps, each of which took a team of lawyers and staff weeks to develop, you can see why Six Sigma for Dummies (p. 10) says the approach is “not for the faint of heart. It is intense and rigorous, and it entails a thorough inspection of the way everything is done.”

In my book, Legal Project Management, Pricing and Alternative Fee Arrangements, I described how Seyfarth has spent more than 10 years and millions of dollars refining its system. They have trademarked the term SeyfarthLean® and formed a separate company—SeyfarthLean® Consulting—as a wholly owned subsidiary which offers advice to law departments on how to work more efficiently. However, the Seyfarth model has been so widely publicized that some law firms think that LPM equals process improvement.

We have frequently argued for a much broader definition of LPM, including any activity that increases client satisfaction and firm profitability by applying proven techniques to improve the management of legal matters. Thus, we see LPM as an umbrella term that embraces a very wide range of management techniques, including pricing, communication, process improvement, and much more.

Under this broad definition, process improvement, Six Sigma, and Lean are simply specialized approaches that fall under the more general umbrella term LPM. They are simply tools in the belt, to be used in some cases and ignored in others.

And when they are used, we recommend always looking for simpler and more efficient approaches, starting with the four approaches described in the next two parts of this series.

May 11, 2016

This is one of the longest series of posts in the eleven year history of this blog, because there is currently so much controversy about the best uses of task codes. A much shorter summary of this research was published recently by the Bloomberg BNA Corporate Counsel Weeklyand reprinted in the Bloomberg BNA Corporate Law & Accountability Report.

This series of posts summarizes new conclusions and recommendations based on our experience working with lawyers in numerous firms, on published reports by a number of experts, and on interviews we recently conducted with 12 experts who have had significant experience using task codes to plan and track legal budgets:

To maximize the frankness of participant responses, we promised that while their names would be listed in our research summary, no quote would be attributed to a particular person or firm. In addition, all of them reviewed a pre-publication version of this section of this summary and had an opportunity to remove or edit any of their quotes before publication.

The main reason that these and many other experts have increased efforts to implement task codes over the last few years is easy to understand: To remain competitive in an ever more challenging marketplace, firms are being forced to predict and control legal costs better than ever before.

Several of the people we interviewed reported that their use of task codes had already produced a payoff:

We have seen immediate benefits in tracking our alternative pricing arrangements and working to budget. The use of task codes takes the guesswork out of the budget.

Some partners have actually landed new work because the firm has a task code system in place. A number of potential clients won’t even deal with a law firm that doesn’t have such a system.

Task codes have been useful in helping track matters against budget, so they are already paying dividends.

We use task codes to price better, to help attorneys manage better, to determine what our profitability drivers are, and to make the business case for alternative staffing models.

Task codes make it easy to have a conversation with the client who wants to know where things stand in terms of the matter and its budget. For us, task codes have also been an integral part of the AFA process. We can offer a flat fee for, say, a motion to dismiss because we can see how much a motion to dismiss has cost us historically. Also, task codes help attorneys see the budget vs. actual reports for any matter and see what, if anything, has changed from the original budget. Was there a change in scope?

Even at firms where there has been resistance to using task codes, the lawyers that have used them have reported benefits:

In my personal practice, the use of phase codes has been very helpful in improving estimating and budgeting.

One expert we talked to has developed about 10 different templates so far for various transactions:

If an attorney is starting one of those types, he or she just goes to the template and builds a budget. These templates can compare actual versus budgeted time on any phase of the matter. You simply look at a picture of what the transaction will probably be in advance and compare it to what actually happens. In addition, there is another advantage: You never forget anything. The template prompts you to remember each needed step, and each task within the step, so you budget better as a result.

Originally we included a brief history of the most widely used system – UTBMS, the Uniform Task-Based Management System – starting from the fact that the system was designed in the 1990s primarily by clients who wanted to standardize e-billing and understand and control costs rather than by law firms who wanted to predict costs.

Many clients, especially in insurance defense, require law firms to use task codes in e-billing as a condition to getting paid.

Unfortunately, what started out as an effort to create a universal language for analyzing legal work later evolved into a system in which many clients tweaked the system to fit their unique demands. For example, in 2007 the UTBMS Insurance Update Initiative issued a slightly revised set of codes to better meet the needs of insurance companies.

As one expert put it:

Sometimes it seems every client wants to use a different set of task codes. For example, one Fortune 50 firm doesn’t use L-codes [for litigation], it uses what they call K-codes. If the clients think the codes don’t tell them what they want to know, they just make up some new codes.

Another summed up the situation like this:

The problem with standards is that so many people have different ones.

In some cases, a single lawyer may have to use two different codes for exactly the same type of work performed on the same day for two different clients. If one wanted to maximize human error, it would be hard to come up with a better system.

This problem is so common that some legal financial software vendors have added automatic translation features so that all the lawyers in a firm can use one standard codeset and have it automatically translated into different codes for different clients. However, these algorithms require painstaking mapping and assume that there is a one-to-one correspondence. If a code in one system overlaps with two or more codes in another system, no algorithm in the world can do an automatic translation.

Despite these barriers, in the last few years many law firms have invested significant effort in using task codes to better track time and cost and ultimately to respond to client demands for more predictable costs. The remainder of this series will explain six key lessons they have learned to date:

February 24, 2016

In addition to pricing, several of those interviewed stressed process improvement, as in these examples:

I spend most of my time working with practice group leaders and individual partners to identify problems and opportunities for increased efficiency for the firm.

My major goal is to educate the lawyers on process improvement solutions, to make their jobs easier.

My chief goal is to help attorneys constantly plan their matters well and to think of new ways to do the firm’s work. This is particularly useful in IP, because patent and trademark prosecutions often involve the same steps repeated in the same way, so careful attention to each step can save time and effort.

Our major achievement has been to teach lawyers how to deliver legal work in the most efficient way through process maps which show the most efficient paths to achieve a variety of legal goals. For clients, the results are reduced costs, greater predictability and transparency, more efficiency, better use of technology, and better legal and business outcomes.

Several people we interviewed also mentioned their role in helping lawyers to think more clearly about profitability:

My group has helped introduce the concept of profitability of a particular engagement into the law firm’s thinking. Profitability is not the amount that is billed; it is, broadly speaking, what remains after paying associates and everyone else who is involved in the matter.

A few mentioned improving communication. One said that:

The major advantage of LPM is to improve communications between the firm and its clients so that the client can understand what is going on at all times. We also use end-of-case reviews to evaluate what we did right in a case and what could be improved.…Through the appropriate use of LPM, I believe our firm can improve its realization by two percent annually on a consistent basis.

Several talked about working directly with clients, as in these examples:

My work is heavily client-driven, since the firm’s clients are much farther along in their understanding of value and efficiency than some of the partners are. My role is to be a liaison between the firm’s clients and its partners…. The firm’s partners let me work directly with clients and understand what makes them tick. My job is to work with each client and to find out exactly what they’re looking for from us. Do we want to partner with our clients to utilize new technology and to take advantage of innovation? Do we want to propose arrangements based on reduced rates and still remain profitable?

For the next year, my priority is to increase my visibility in client meetings—attending them more often and serving as more of a support system for the partners.

Whether it’s the result of differences in firm culture or in the way that LPM director roles have been defined by management, there are differences in the degree of lawyer acceptance. On the positive side, one respondent reported:

While there are pockets of resistance, they are not vocal or persuasive.

More commonly, there was greater resistance to LPM:

In my director role, I need to have a thick skin vis-à-vis the attorneys. You are talking about people who have worked the same way for years. You can’t force people to change.

My most important challenge is building relationships with the partners and developing their trust.

The biggest barrier to success is the need to instill a sense of urgency among the attorneys.

My major obstacle, in addition to technology, is dealing with a subset of partners who want to do things the way they have always done them.

I have a real question whether most lawyers have the resiliency to make changes in the way they practice law.

Another common theme was that the resources available for LPM are too limited. Indeed several directors described lack of time as their single biggest problem:

The biggest obstacle to achieving my objectives is the number of hours in a day.

Everyone is too busy. I just wish I had more time to show everyone the framework that’s in place.

We know that our clients all over the world are interested in budgeting. We need to have the resources available in our department to answer all these client questions.

The question is, how do we staff everything when we have so few people to achieve all our goals?

This high demand is a good thing in that it proves that LPM directors are making progress in showing attorneys the benefit of LPM. But it also implies that going forward the biggest questions for firm management will be how much to invest in LPM and which activities produce cost-effective changes most quickly.

Our 15 interviews revealed 15 approaches to these tactics, some of the differences subtle and others quite significant.

To those views we would add a 16th opinion about what works best, based on our experience working with a number of firms. Our general approach is summarized in our article “LPM: An evolving process” in the February issue of Managing Partner magazine. As we wrote there:

Too many firms act as if hiring an LPM director and/or a pricing director will solve all their problems. This is clearly part of the solution for many firms, but it only works if partners are committed to changing their approach.

LPM and pricing directors are hungry for information about what works and what doesn’t. A number of thought leaders have banded together to form the True Value Partnering Institute , described on its web page as “an invitation-only virtual Think Tank… [which organizes] Cohorts which meet several times via one-hour conference calls and can also participate in specialty topic Sub-Groups to collectively explore topics of interest.” For example, their “Legal Project Management Leaders” Cohort has a sub-group devoted to “Defining the Role and Measuring the Value of a Legal Project Management Director.”

As a result of our interviews, we recently expanded our LPM Acceleration Program to include a wider variety of services to support in-house LPM directors, as well as access to the proprietary scripts and guidelines we have developed over the last several years.

Whether a firm accepts our recommendations or those of others, the most important conclusion from this research is that firm management must play an active role in defining the best way to implement LPM. Fundamental questions regarding the firm’s business approach to profitability and client satisfaction are simply too important to be delegated.

As we reviewed all of our findings, the good news was that these 15 firms and many others are devoting significant resources to meeting client demands for greater efficiency, and that all of them are making progress.

But there is still a great deal of work to be done and LPM directors currently disagree about the best approach to using limited resources. The challenge is to find the tactics that will produce the greatest benefits for each firm, in the most cost effective way possible.

All this at a time when the pace of change needs to increase. In our survey of Client Value and Law Firm Profitability, when we asked AmLaw 200 leaders, “Will firms have a competitive advantage if they change more quickly?” 85% said yes, they would.

At the end of the day, the burden is on the partners who own each firm and on the firm’s management committee to review all the conflicting opinions about LPM tactics and make the best decisions they can in an uncertain environment.

January 20, 2016

Managing partner Rob Romanoff provided a specific example of how our scope workshop related to an ongoing matter where a client requested some work for a flat fee:

This was in an area where we typically work on an hourly basis because there are so many things that can’t be predicted. We only represent one of the parties, and we don’t know the other party’s lawyer, so this could go on a while. But in the email where our client said he wanted us to do this work, he repeated more than three times that he wants it done for a flat fee…

One of my partners who wasn’t at the scope workshop said “we really can’t do this for a flat fee.” My response was that the client had made it very clear he wants a flat fee. We can’t simply say “no”!

So the pricing partners broke down the core phases with a detailed analysis of scope, and we agreed to work on a flat fee basis for drafting the documents. When we begin negotiating with the other party’s lawyer, at that point it will be billed on an hourly basis going forward.

It could be a win-win both for the client, in terms of certainty of costs, and for us, either not being taken advantage of or having to take on all the risk that the other lawyer will delay the process and drive up the fees.

David Solomon, another workshop participant and a partner in the Corporate & Securities Group offered a different fixed fee example, and explained how the course had led him to refine and improve a process that the firm was already using:

In the past, we have set up our budgets based on a pricing matrix which combines our experience with some input from our pricing people. Then I’ve been putting together simple intuitive spreadsheets to show the client the status of the budget and taking time with our bills to allocate out all of our time to each bucket of the project. Then I’ve been sending it to the client without any editorial comments.

But for the last couple of project budget status reports since the workshop, I’ve sent quite a few editorial comments about exactly where we are, especially if we are higher on certain things, and telling them where I predict we’re going to be. This helps set the stage for when there may be scope changes, as opposed to waiting until there actually has been a scope change. It’s been very effective.

Stuart Kohn, Head of the Trust and Estates practice group, gave another example of how the workshop helped him improve a process that was already in place:

A lot of the work we do for estate planning is based on flat fees that cover creating the documents. But for work after they sign, such as funding their trust, we bill them hourly. We state that in the engagement letter, but I think the need to have the conversation again to remind them and to clarify is really important, and that was a good highlight of the workshop.

Also, we already use an estate administration checklist internally to guide our work and activities on a matter. But now we will take that one step further and incorporate that description of our work into the engagement letter.

Another key reminder was that it is better to talk with the client along the way about scope changes as opposed to waiting till they get a bill and complain, and we deal with it after the fact.

Overall, I thought it was a great workshop. Incredibly helpful! The materials are really valuable and I have gone back over them a couple of times.

The benefits of the program extend not just to client interactions, but also to internal communications within the firm. Marc Fineman noted that:

The value of a specific scope statement carries over to delegating and supervising tasks that are assigned to others. That means that you have to 1) give people on your team the benefit of knowing the scope of work that has been developed and 2) make sure that they operate within that scope of activities… so that things don’t go off the rails. I realized after the workshop that this is something I need to work on myself, and I’ve already started.

I can have it all in my head and know what the budget is, but everybody that is working on it also needs to know. So at our last team meeting, I showed everybody’s budget, how it was spread and especially in their particular area. And I urged them “…when something seems to be going awry, raise your hand and tell me.”

I certainly think the team will benefit from seeing the entirety of what has to happen, and this will help get their agreement/ buy-in to all the things that go into the plan. Also, their involvement will help me to make sure that when I’m creating a budget I’m not forgetting something.

Instead of avoiding conversations about scope, our partners now recognize that this is a business process and that it only gets better with more give and take, as opposed to just hiding from the discussion, and hoping it all will work out in the end.

In addition, the workshop tips for how to handle a fee increase negotiation has had a positive impact on our partners to rethink the client relationship. I heard some light bulbs coming on in conversations among our partners when they discussed how negotiating is sometimes a natural part of the process. It’s not distasteful, it’s not bad, it’s something that we should embrace, expect and plan for. And it does not have to be adversarial. It could, instead, be a way to get to every party’s interests.

After all, it is a business transaction and most clients are used to negotiating the terms of everything: contracts, agreements, standards, and processes. Clients don’t find it distasteful to negotiate. It’s just business as usual.

December 30, 2015

Whether one uses a narrow definition of AFAs or a broad one, from a law firm’s business perspective, one of the most important questions about AFAs is whether they are profitable.

In 2002, the ABA Commission on Billable Hours Report (American Bar Association, 2002) predicted that the non-hourly approach would be a financial boon to law firms: “Alternatives that encourage efficiency and improve processes… increase profits.”

Many consultants love to spread this good news message, and when law firms and law departments talk publicly about the topic, they too often focus on the upbeat side. For example, James D. Shomper and Gardner G. Courson argue that “if properly structured, an alternative fee arrangement should result in a win-win scenario for client and law firm.”

To cite another example, a New York Times article about alternative fees quoted Carl A. Leonard, a former chairman of Morrison & Foerster, about AFA profit potential:

In one case... Morrison & Foerster negotiated a fixed fee for defending a company in court, covering work up to the point of a motion for summary judgment.

On top of the fee, if the case settled for less than what the company feared having to pay if it lost in court, the law firm got a percentage of the amount saved. The arrangement made sense when the goal was to resolve the dispute quickly....

Lawyers on the case negotiated a settlement for much less than the client’s worst-case number, Mr. Leonard said. “The effective hourly rate was something like 150 percent of our hourly rates,” he added. “We made money, the client was happy.”

However, the data suggests that such happy outcomes are not the norm. It can be very hard to turn fixed prices into win-wins, especially in a highly competitive market.

Lawyers have been rewarded for their entire careers for putting in extra hours to analyze every risk from every possible angle. Many will have a hard time learning to deliver the quality they are comfortable with when they must work within strict funding limits. And law firm managers will have an even greater challenge when they try to juggle staff on dozens or hundreds of projects with constantly shifting deadlines. If a firm expects lawyers to bill 1,800 hours per year or more and shifts a significant portion of their work to a fixed price basis, many will find that goal unreachable.

One of the biggest pressures on AFA profitability is the fact that in many firms, lawyers are paid more if they bill more hours. Several participants in the LegalBizDev Survey of Alternative Fees noted that without proper management, AFAs can be seen as a giant loophole, a place where lawyers who have too little to do can bill as many hours as they like without risking client complaints:

It takes a lot of discipline to manage a contingent matter. When lawyers track hours on a traditional hourly project, they know that clients will review the results, and that creates a certain discipline. On contingent matters, lawyers may think no one will look at the hourly record for years.

One of the lessons [we’ve] learned is that somebody has to be the point for cost control. It often happens that alternative fee matters, particularly large ones, [end up being] a dumping ground for individuals who may not be fully employed because you are reportable to the client for the result, not the cost. [When lawyers work unnecessarily on a project] your profitability looks bad, so in order to really determine the profitability, we need to deal with that issue.

Some relationship partners we’ve worked with encourage associates to put in extra hours on AFA matters. Associate salaries are a sunk cost, the partners reason, so they might as well put in extra time to assure quality and client satisfaction on fixed fee matters. It’s more productive than Googling or staring out the window.

In the short term, they have a point. But in the long term, this type of thinking is highly counter-productive. It reinforces the bad habits created by decades of hourly billing and substantially increases the chances that AFAs will be unprofitable.

It is not surprising that systematic data on AFA profitability is hard to come by. Law firms are notoriously secretive about their finances, sometimes even with their own partners. And nobody likes to talk about their losses.

The best available data on the topic of AFA profitability comes from Altman Weil’s annual Law Firms in Transition Surveys. When the most recent survey asked, “Compared to projects billed at an hourly rate, are your firm’s non-hourly projects more profitable or less profitable?” the results were 16% more profitable, 38% the same, 32% less profitable, and 15% not sure.

Even more interesting were Altman Weil’s findings about which firms profited the most. When Altman Weil asked, “Is your firm’s use of alternative fee arrangements primarily reactive (in response to client requests) or primarily proactive (arising from your belief in the competitive advantage of alternative fees)?” about one-third said they were proactive (32%) and two-thirds classified themselves as reactive.

When Altman Weil compared AFA profitability for the two groups, they found that it pays to be proactive. For proactive firms, 29% of AFAs were more profitable, compared to 10% for reactive firms.

But if firms are not making more money with AFAs, why are they offering them? Because in today’s competitive environment, many feel they have to.

The perspective of law firms vs. law departments

When both inside and outside counsel talk about alternative fee arrangements, they will probably continue to accentuate the positive and focus on win-wins. People will speak most freely about the matters that make them feel good and look good. But in fixed price deals one side often wins a revenue concession and the other side does less well.

It may come down to how we define “winning.” I think a win-win alternative billing scenario right now might look like this: the client wins because it reduces its outside legal spend, or at least improves its legal cost certainty, and the law firm wins because it gets to keep the client for one more day. That’s not the kind of victory lawyers are accustomed to settling for, but I think they ought to get used to it.

In the ALM Legal Intelligence survey, when law departments were asked, “What role did receptivity to AFA pricing play in any changes your legal department has made to its

roster of outside counsel?” 49% said it had indeed played a significant role.

And when the same survey asked law firms to name the top benefits of AFAs, number one on the list was “Attracting or maintaining clients” (49%). (For law departments, the top benefit was “Cost predictability/transparency” at 44%.)

So it is not surprising that twice as many law departments (40%) as law firms (19%) said they were very satisfied with AFAs.

And when asked to predict the growth rate of AFAs by the year 2019, law departments predicted a greater increase in AFAs (34%) than law firms did (24%). They should know. The client is always right.

December 23, 2015

Before leaving the discussion of types of AFAs, it is important to note that the ALM Legal Intelligence survey also included the category of blended rate, which was reported by 39% of firms. These are 100% hourly arrangements in which a single middle rate is charged for senior lawyers who normally charge more and junior lawyers who normally charge less. Whether the client or the firm benefits from this arrangement depends on the actual numbers in a particular situation.

For example, consider a case that is expected to require 100 hours of senior time at an average of $500 per hour ($50,000) and 100 hours of junior time at $300 per hour ($30,000), for a total of $80,000. A firm might offer a blended rate of $350 per hour, which reduces the predicted cost of the matter to $70,000 ($350 times 200 hours).

But now suppose that once the matter is underway, the firm discovers that almost all the work could actually be performed by more junior lawyers. If the senior lawyers only need to spend 20 hours supervising the matter (which would have cost $10,000 at the original rate of $500 times 20 hours), and junior lawyers put in the other 180 hours (which would have cost $54,000 at $300 times 180 hours), the client who pays the blended rate will actually pay more ($70,000) at the blended rate than they would have at the non-discounted rate ($64,000).

Now you could argue that it’s still a win-win, because if the firm had not offered blended rates, senior lawyers would have delivered 100 hours out of the 200. The client won by paying $70,000 instead of $80,000, and the firm won by charging $70,000 instead of $64,000.

From a marketing perspective, that is a terrible argument. In essence, it implies that senior people never should have been doing the work in the first place and the client must agree to be overcharged a little in order to avoid being overcharged a lot.

Blended rates invite gamesmanship, as individual lawyers may be tempted to manipulate predictions to maximize profit. And they encourage the use of more junior level lawyers, even when it may not be to the client’s benefit. Here’s how the general counsel at Marriott International described his unhappiness with his blended rate experience: “The law firm only assigned to the matter those lawyers whose regular hourly rate was at or below the blended rate, and more senior lawyers were unwilling to engage in significant supervision.”

We will leave it to others to argue about whether blended rates are a good thing or a bad thing. In this context, what is important is that there is a philosophical difference between two types of AFA definitions: narrow and broad. These days most people use the narrow definition, which reserves the term “alternative fee arrangements” for fees that are fully or partly non-hourly. The broad definition used by the ALM survey and others also includes blended rates which are 100% hourly, but offer a single hourly rate that applies to all lawyers on a matter.

The fact that two conflicting definitions of AFAs are in wide use adds considerable confusion to an area that was already confusing enough. If a firm claims that 50% of its work is performed on an alternative fee basis, that could mean that they are moving away from the billable hour (under the narrow definition), or it could mean that they are engaging in some creative hourly rate discounting (under the broad definition).

Some have a vested interest in maintaining this confusion. Announcing that a firm offers 50% of its work on an alternative fee basis sounds much more thoughtful and less desperate than saying, “Half the time, we have to slash our hourly rates because we need the business.”

December 16, 2015

There is no universally accepted taxonomy for classifying all the possible types of AFAs, but there is good data on which types are most common. The graph below is based on a recent ALM Legal Intelligence survey and includes the seven most common types of arrangements:

The most common arrangement (reported by 60% of firms) is a fixed fee, which is a mutually agreed sum for a set of well-defined services. It could apply to a single matter or a portfolio of matters, such as a single fee for handling all of a Fortune 100 company’s US labor and employment litigations in a single year. In order to succeed with this approach over the long run, defining scope clearly at the start is absolutely critical. It also helps if firms have many fixed price deals, since they will surely win some and lose some. This arrangement can be risky with new clients until mutual trust and understanding has been established.

Next most common are contingent fees (43% of firms) which are paid only if the firm succeeds in producing a financial recovery or other mutually agreed result. This approach has long been used by plaintiffs’ lawyers, but it is now becoming more common for the defense to use as well.

With partial contingencies or success fees (37% of firms), a law firm typically receives part of an hourly fee or fixed fee, and a lump sum—or success fee—at the end of the matter, but only if it achieves a result desired by the client. Criteria for success fees are sometimes spelled out at length and sometimes left entirely to the client’s discretion. Clearly this can have the benefit of aligning the interests of clients and their law firms.

With capped fees (36% of firms), hourly rates are charged up to an agreed maximum amount for a particular matter. Beyond that, if additional work is required to complete the matter, the law firm pays for it. Of course, this is really just hourly billing with a twist: a hard limit on the maximum. Some lawyers see fee caps as the worst of both worlds—you can do worse than hourly, but you can’t do better—and refuse to do business this way. While this arrangement does clearly benefit the client more than the law firm, other firms see fee caps as an inevitable element of the changing legal landscape, and an important way to get new work.

Next most common are phased fees (30% of firms), in which firms have a separate fee—whether hourly or AFA—for each phase of a matter. This can be especially useful in situations where it is relatively easy to predict the amount of work required in the short term but where the long term need is uncertain. In essence, both the client and the firm agree on one predictable phase at a time.

Risk collars, the sixth most common type on this list (17% of firms), are in my judgment the most interesting, because they can truly align the interests of clients and law firms by offering incentives to both. The term generally refers to a billing arrangement built around an estimated budget for a particular matter in which the client pays a bonus if work is completed under budget and/or gets a discount if the work goes over the budget. The ways risk collars can be structured are limited only by the imagination of the lawyers involved. The table below provides six examples reported by interviewees in the LegalBizDev Survey of Alternative Fees. Example 1 is the “best” for clients and firms that want to share risk equally and fully align their interests.

However, it must be pointed out that many clients want the law firms to take more risk. Indeed, in the ALM survey they did not ask about the familiar term “risk collar” and instead used the term “flat fee with shared savings,” which is a particular kind of risk collar in which client and firm share any savings if the hourly fees turn out to be less than a fixed fee. In this arrangement, if the hours exceed the fixed fee, only the law firm is at risk. Presumably this definition was selected by ALM because more firms are taking risks these days than clients are, since it is a buyers’ market. If they had used the more neutral and more common term “risk collar,” the total would have been greater than 17%.

Finally, the seventh and last type of AFA used by more than 5% of firms was the holdback (9%), an arrangement in which the law firm is guaranteed to receive part of its fees but where the other part is paid only upon achievement of a certain milestone or result. For example, a firm may receive 80% of its negotiated hourly rates while a matter is underway. At the end of the matter, the firm may be awarded the remaining 20%, or less, depending on the client’s satisfaction with the result.

December 09, 2015

One of the main forces driving interest in LPM has been the growth of non-hourly alternative fee arrangements (AFAs), especially fixed fees. Nothing gets a lawyer thinking about efficiency faster than knowing that if they go over budget, they will have to use their own money to pay for the cost overrun.

In 2008, when the AFA buzz was first building, we interviewed senior decision makers at 37 AmLaw 100 firms for the LegalBizDev Survey of Alternative Fees. Those interviews revealed a significant split of opinion about the future of AFAs. At one extreme, some chairs and managing partners said AFAs could rapidly replace the billable hour in many practice areas. At the other extreme, some felt AFAs were just another fad that would soon fade away.

Since then, surveys have consistently shown that both extremes were wrong. AFAs have neither exploded in popularity nor disappeared. Instead, there has been slow and steady growth, year after year.

In its annual Law Firms in Transition Surveys for the last several years, Altman Weil has asked firms to estimate the change in non-hourly billing revenue. Since 2011, the percentage of firms who reported an increase in AFA revenue over the previous year has ranged from 43% to 58%, while only 1% to 5% have reported that AFA revenues went down.

Similarly, in the 2015 survey Who Really Drives AFA Use—and Why? ALM Legal Intelligence found that 40% of firms and 48% of law departments reported an increase in “AFA volume” the preceding year.

While most surveys in this area have been limited to the perspective of either law departments or law firms, this particular survey took the unusual step of interviewing both: senior managers at 197 law departments and partners at 114 law firms that use AFAs. The complete survey includes data on such topics as reverse auctions, whether clients limit billing by first and second year associates, how often do they discuss an AFA but then decide to do hourly, who approves AFAs, what are the perceived benefits by firms and departments (quite different, not surprisingly), obstacles to growth, the use of software, task coding, ratings of law firm profitability and law department savings, and predictions for the future.

In the context of this post, the most important finding is that it is crystal clear that the use of AFAs is growing. However, it is almost impossible to precisely determine the percent of law firm revenue they represent. There are many reasons this question is difficult to answer, including law firm secrecy about finances, disagreements over the definition of the term “alternative fee arrangements,” and the fact that some firms simply do not know. In the Law Firms in Transition Surveys, 6% to 13% of firms said they did not even know whether their firm’s AFA revenue had gone up or down the preceding year, much less exactly what the percentage was.

While we may never know the average percentage of AFA revenue for all firms, we do know that there are wide differences between firms. In Altman Weil’s most recent survey, about one quarter of firms reported 5% or less of their revenue came from AFAs, one quarter said 16% or more, and the remaining half fell between 6% and 15%. The median value of AFA revenue—that is, the mid-point, with half the firms above it and half below—was 10%.

While in some ways that may not sound like much, if you apply 10% to the $100 billion of annual revenue for the AmLaw 200, it implies that about $10 billion worth of legal work was performed on a non-hourly basis. And the figure is going up.

November 25, 2015

Just about everyone agrees that legal clients are demanding greater value these days. But what exactly do clients mean by “value”? As a senior executive from one AmLaw 200 firm summed it up in my research for the book Client Value and Law Firm Profitability:

The truth when it comes to value is that I’m not sure what our clients mean. It means different things to different people.

While there will always be individual differences between clients, it is useful to start by knowing what clients in general mean. Altman Weil’s recently published 2015 Chief Legal Officer’s (CLO) survey provides significant insights into this issue based on answers from 258 CLOs. (Full disclosure: Altman Weil is a strategic partner of LegalBizDev, but I’d write about these findings even if we weren’t.)

From the law firm point of view, I think the most interesting question was “Rate the value to your law department of the following things law firms can do to better understand your organization.” Here are the results:

If you are involved in legal marketing, it would be interesting to rate the time and money that your firm devotes to each of these ten items. In my experience, most marketing departments are investing heavily in exactly the wrong things: numbers 8, 9 and 10 (the old marketing), instead of numbers 1, 2, and 3 (the new marketing).

Four of the top five items are examples of legal project management. As I noted in my recent article for Bloomberg BNA’s Corporate Counsel Weekly “Why Law Firms Must Change their Marketing Priorities”, a few firms are headed in the direction of putting more emphasis on LPM, but most have not yet adapted to the changing needs of the marketplace.

Another important question in this year’s survey asked: “Of the following [ten] service improvements and innovations, please select up to three that you would most like to see from your outside counsel.” The top three, according to 258 CLOS, were:

Greater cost reduction (selected by 50% of respondents)

Improved budget forecasting (46%)

More efficient project management (40%)

It is worth noting that this question has been asked for the last several years, and these have consistently finished as the top three. Since LPM leads to #1 and #2, and is the very definition of #3, I like to sum up the results by saying that what clients want most these days is LPM, LPM, and more LPM.

How well are law firms doing in meeting this client needs? Not very well. When CLOs were asked “In your opinion, in the current legal market, how serious are law firms about changing their legal service delivery model to provide greater value to clients (as opposed to simply cutting costs)?” On a scale from 0 to 10, the median rating (with half the firms above and half below) was 3. These results were almost identical to last year’s, so despite all the press releases law firms are putting out trumpeting their successes in increasing value, clients have not been impressed by the results.

The complete survey includes a great deal of additional information on law departments, and can be downloaded for free. Now that’s what I call value.